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  1. Hi,

    Is 1.4799 (future price on 12 September) the lock-in rate? If yes, the net payment is $500,000 / 1.4799 = 拢337,860?

    But the answer is different with example 11, payment at spot rate on 12 Sept 拢338,043 – profits on future 拢865 = net payment 拢337,178.

    I am still confused on when using the lock-in rate to calculate the net payment, and when using the payment at spot rate -/+ profits or loss to calculate the net payment.

    Thank you.

    • No – 1.499 is the futures price on 12 September and is not the lock-in rate.

      As to which approach to use, it depends on the information given in the question. If you are given the spot rate on the date of the transaction then you convert at spot and add/subtract the gain or loss on the futures. If you are not given the spot rate at the date of the transaction then you use the lock-in rate.

  2. Thank you very much for valuable lecture, would you please let us know Foreign currency swap is not there in the lectures… is it part of syllabus?

    • Yes it is, but is rarely asked.

      When it is asked it is basically the same as an interest rate swap, except that for the need to convert the currencies. The rates to use for conversion depends on the agreement, and they are therefore given in the question and so for that it is very much just following the instructions.

      You should find one or two questions on it to practice in your Revision Kit. Any problems then ask me in the Ask the Tutor Forum.

  3. Hello Mr.John,

    first of all your explanation is prefect indeed, you have the ability to simplify even the most complicated stuff, so many thanks to you.
    but there is one thing I would like to ask, about the estimating the future price at the date of the transaction, it seems not so logical to me cause if we came to know the spot rate at the date of the transaction (here it is 12 sep) so it means we are on that date and the future price should be available as well, What I do mean, this way of estimating is not really helpful in ral life because in order to use this method you need the spot rate which will only be available at 12 sep according to what I did understand.
    It would be a better method if we can estimate the future price before the date of the transaction, or not ??

    • Ohhhh thats really interesting, actully when I asked you I have not complete the lecture, but now you even make it more interesting, So by using this method we can predict in advance the diff in the movement which is (0.0016), So can we use that diff to estimate the future rate from the beginning (20 of june) ?

      • That is correct. However, also watch the lecture on the lock-in rate, because we can forecast from the start what the net effect of converting the transaction at spot together with the gain or loss on the futures – whatever the spot and futures prices end up being.

  4. Dear Sir,

    In this example, we under-hedged $500k – 5 x 62,500 x 1.4840 = $36,250. If we want to use forward market to deal with this amount (say the forward rate in Sep is 1.5), should we add or deduct this amount to get the net outcome and what would be the net outcome? How would this change if we over-hedge (say we sell 6 contracts rather than 5, which leaves the over-hedged amount of 6 x 62,500 x 1.4840 – $500k = $56,500)?

    Also, how would it change if we were to receive foreign currency rather than paying the suppliers in the case of over-hedge and under-hedge?

    Thank you so much Sir.

  5. Hey, John, I was wondering what would we do with the futures contract if the contract size was quoted in the foreign currency. Will we sell futures then? Does the contract currency affect, other than no of contracts, the buy/sell rule when we are paying in fx?

    Apart from this correct me if my understanding is wrong. We buy futures when we pay overseas because we fear that rates will go up, so if they go up we will lose on the transaction but gain on the futures and for receipts, it is the opposite.

  6. Hello,

    Could you please explain why you used the selling rate $1.4812 to convert at spot for the profit/loss on the future on Nov 12?

    Noting that its a payment, why didn’t you use the buying rate of $1.4791 to convert at spot for the profit/loss on the future?

    I am confused as in example 9, it was a receipt and you used the selling rate of $1.5190 to convert at spot rate for the profit/loss on the future. I understood this, but in example 11, you used the selling rate for a payment, this is puzzling to me.

  7. Thank you very much John. I develop good concepts when I watch your fine lectures.
    I am little worried about the futures. You see when we get into future deals, we want to hedge against the risk of transaction risk right, depending on whether we buy or sell the transaction currency on the transaction date, we buy/sell in the futures deal in that currency.

    Futures give a right to a fixed rate on fixed sized contracts on a fixed date, however that right can be traded with differing prices on which profit/loss can be made. It is basically a bet on the future prices to make a profit/loss before the end of the futures contract?. so far I am correct isn’t it ?

    Now my real worry is we bought a futures deal, the prices went up we sold it before the end of the contract we made a profit great.
    However, when we sell a future first, we buy at later (hopefully) so that prices may come down in order to make a profit. But by doing so, we have completed the transaction haven’t we?. That means we are now committed to whatever the price of the contract might be on the last day of the futures contract and take the contract?.. I know this can’t be the case but why I can’t explain to myself.
    Please help me here
    Cheers

    • Yes – your first two paragraphs are correct.

      With regard to your last paragraph, you can look at it two ways. In a sense you are just gambling and are not really buying or selling anything – just gambling on the price changing. If you prefer, then the other way of thinking about it is that you are ‘borrowing’ a future from someone else, so that you can sell it today. Later you have to pay the person you ‘borrowed’ it from (which is when you later buy the future from them).

      • So you are saying I will borrow the future from someone and sell it. Hoping that the prices would come down. When the prices do come down, I’ll buy it and give it back to the person I borrowed the future from in the first place at a NEW rate? – keeping the difference which would be a profit to myself?.
        IF that is the case why would anyone lend a future when they will lose money ?…

  8. when calculating the # of contract, we use amount / futures rate / size – this is in the case when we have to make a payment.

    do we use the same formula when we are getting money?

    thank u

  9. Hello Sir

    My question is why are you using a mid rate for the spot? Can we not instead use the relevant spot rate and compare with the futures rate in estimating the initial basis? For instance, if a UK company has a transaction involving making a payment in dollars, then shouldn’t we just use the dollar buy rate?

    • It is because there is only one futures price (whether you are buying or selling futures).

      Although there is no strict rule (because what we are doing is only approximate anyway because the basis does not fall linearly) it makes more sense to compare it with the mid-market spot rate.

  11. Dear Mr. Moffat,

    I was thinking about why should we make a decision about buy or sell futures in order to construct a hedge. By the end of hedge it makes no difference from where you lose or benefir (transaction or futures). It seems to me that by constructing hedge today we just fix today’s terms for conversion. In other words, I could effectively buy or sell future and still be nearly in the same position as today.
    So why do we need to chose buy or sell?

    Thank you very much for your efforts!

    Kind regards,
    Murat

  14. Dear Mr Moffat

    In this example 11, when calculating the basis, you are using the mid-point rate against the futures. Can we use the spot on 20 June is 1.4821 instead?

    Thanks

    Hanhvn

  15. Hi sir , when estimating futures price(Example 11) can it be correct instead of using mid-spot rates I get lower spot rate on 20 June and lower spot rate on 12 Sept.?

  16. Hi! Sir are we not supposed to use 1.4791 as the rate to convert the profit?? The same rate as the transaction? You used the same spot rate for the transaction and for the future profit/loss calculations in the orevious examples to. Over here im confused regarding this point. Please clarify?

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